In the following report, we take a closer look at water and wastewater infrastructure

spending and its drivers. Specifically, we examine the origins of state and federal funding
for water and wastewater infrastructure projects, as well as historical water rates across the
United States and Europe.

Key Takeaways
• CWSRF allotments (federal funding) are down (49.41%) since 2000 and (66.94%)
since peak funding in 1991.
• The American Recovery and Reinvestment Act of 2009 authorized $4B for the CWSRF
program and $2B for the DWSRF program in FY2010.
• Water rates are used to pay for 90% of waste/wastewater infrastructure, which we
believe to be unsustainable due to comparatively low water rates in the U.S., as
compared to Europe.
• U.S. water rates have room to move – average price in the U.S. is $3.37 per thousand
gallons, compared to over $10 in Europe.
• While state tax revenues are down (11.7%), we don’t expect this to severely affect
water/wastewater infrastructure projects.
• Since 1957, annuak water/wastewater funding has increased, on average, 3.2%, with
peak annual increases of 8-14% for the ten years from 1971-80.
• As a percentage of total yearly federal infrastructure spending, funding for
water/wastewater systems has increased from 19.4% in1957 to 27% in 2004.
• Funding for water/wastewater infrastructure projects increased by, on average, 3%
during the recessionary periods from 1957-2001.
• Companies involved in water/wastewater transmission and distribution are poised
benefit from an EPA estimated 20-year need of $200.8B.

While problems with dilapidated water systems have been prevalent in recent years, the
U.S. is merely at the beginning of what we believe to be the rehabilitation and replacement
phase of the water infrastructure cycle. Last year aliened there were 240,000 water main
breaks in the U.S., which resulted in six billion gallons of water lost per day. While funding
for water and wastewater infrastructure projects has been steadily growing the since the
late 70s, current funding levels are not sufficient to support the needs of a weathered water
infrastructure network in the United States. The EPA recently estimated that there is a
$534B gap between current water infrastructure spending and projected needs over the
next 20 years, or roughly $26B annually. This compares to a total $10-12B in annual water
supply spending over the past 10 years. While funding has indeed been depressed for many
years, we believe that through growing recognition of infrastructure troubles and in an
attempt to further stimulate the U.S. economy, significant water/wastewater funding
increases are forthcoming.

Origins of Funding
Federal funding to aid state and local governments in meeting safety requirements and
environmental laws was originally provided through the Clean Water Act of 1972 and
through the Safe Drinking Water Act of 1974. From 1972 to FY2008, $85.8B has been
provided to states through these programs, with each state being allocated funds based on
a specific formula. Funds provided by these acts are used to finance state revolving fund
programs, through which states offer local communities interest free loans for water
infrastructure projects.
 Clean Water State Revolving Fund (CWSRF)
The CWSRF first funded water infrastructure projects in 1988 and has provided $68B in loan
assistance through 2008. As of 2008, for every $1 that the federal government provides,
$2.41 has been provided in assistance. Through 2008, 98% of the cumulative funds allotted
have been committed to infrastructure projects. Indeed, we believe that states are eager to
spend all available funding and should continue to commit the majority of funds provided by
the revolving fund programs. Despite the seemingly overwhelming support of the
government, CWSRF allotments have actually fallen (67%) from peak funding in 1991 and
(49%) since 2000 - federal funding has moved in the opposite direction of water
infrastructure needs. The American Recovery and Reinvestment Act of 2009 (ARRA)
authorized $4B for the CWSRF program in FY2010. This seems to be a one-time jolt to the
state revolving fund program to help bolster the economy. Given the state of the federal
deficit, however, direct federal assistance may not be sustainable at these lofty levels going
forward.

Drinking Water State Revolving Fund (DWSRF)

In 1996, Congress passed legislation which authorized the Drinking Water SRF program,
which appropriated $1.3B in FY97. While funding decreased (43%) the following fiscal year
and remained at those depressed levels from 1998-2009, ARRA authorized $2B for the
DWSRF program in FY2010, a 141% increase over FY09 funding. As previously mentioned,
this lofty level of assistance may not be sustainable going forward.

Historical CWSRF Allotments Historical DWSRF Allotments

$4,500 500% $2,500

$4,000
400%
$3,500 $2,000

$3,000 300%
$1,500
$2,500
200%
$2,000
M

$1,000
in D
o
la
rs
M

$1,500 100%
in D
o
la
rs

$1,000 $500
0%
$500

$0 -100% $0
97 98 99 00 01 02 03 04 05 06 07 08 9E 10E
9
E
8
9
0
9
1
9
2
9
3
9
4
9
5
9
6
9
7
9
8
9
9
0
1
0
2
0
3
0
4
0
5
0
6
0
7
0
8
0
0
1
E

Source: EPA and Longbow Research

Source: EPA and Longbow Research
 CWSRF Allotments
%Decline Since 2000 -49.41%
%Decline Since Peak ('91) -66.94%

Top Ten: CWSRF Funding by State (FY10E) Top Ten: DWSRF Funding by State (FY10E)

FL AZ
OH TX
MA 3.4% NY 2.8%
3.0% 8.3%
3.4% 11.2%
PA NC
4.0% 3.4%

NJ PA
4.1% 3.4%

CA CA
7.3% 8.2%
MI
MI
3.5%
4.4%

OH IL
IL FL
5.7% 4.1%
4.6% 4.5%
TX NY
Source: EPA 4.6% Source: EPA 4.5%
Noticeable recipients of FY10E SRF funding include California, Pennsylvania and New Jersey –
states in which covered companies own and operate water/wastewater systems.

CWSRF and DWSRF – Unreliable and Unable to Shoulder the Infrastructure Burden
The CWSRF and DWSRF programs were not intended to replace state, local and private
funding of infrastructure projects, but rather act a supplement. Congress originally intended
to phase out the CWSRF in FY1994, but pressure to extend federal funding caused Congress
to reauthorize the CWSRF indefinitely. Though federal assistance has been significant in
dollars amounts, it has clearly been sporadic and significantly less than the needed amount
to restore our systems to full operational efficiency. Furthermore, a Congressional Research
Report indicated that, on average, ratepayers currently pay about 90% of the total cost of
their water and wastewater systems, with the federal government covering the remaining
10%. We believe that this ratio is not sustainable and the federal government will probably
have to foot a larger portion of the bill in the coming years.

The U.S. is similar to Europe (discussed below) in that rates are the primary source of
funding for rehab and replacement. Rates in the U.S., however, are considerably less than
rates in Europe, which is a reason for federal funding programs. Given that the average rate
in the U.S. is $3.37 per thousand gallons, whereas prices are upwards of $10 in Europe, it is
evident that rates alone are not sufficient to fund 90% of infrastructure needs. Furthermore,
since 84% of all water systems and 98% of all wastewater systems are municipally owned,
many of which charge less than the economic cost of operation, the federal government
cannot expect rates to solely finance 90% of the growing infrastructure needs. Many
municipalities are reluctant to increase rates substantially due to political reasons. Through
our lens, we believe the federal government will need to increase assistance in the coming
years to fill the void left between funds generated by rates and what actually needs to be
spent. Another alternative, however, would be for smaller municipalities to sell off their
assets to a private water utility firm, which have the necessary resources to upgrade
infrastructure.

State and Municipal Budget Shortfalls – Worst in Recorded History

We note that while state tax revenues have posted the largest decline since records were
first kept 46 years ago, an (11.7%) y/y decline, we do not expect this to adversely affect
funding for water/wastewater infrastructure projects. As mentioned, water/wastewater
projects are funded almost entirely through the SRF programs, EPA grants and rates
(water/wastewater system revenues), rather than state tax revenues. Indeed, given the
stability of municipal water/wastewater system revenue streams, the SRF program provides
a reliable form of funding which has not been affected by the deteriorating credit market.
States are able to borrow funds well below market value – rates were 2.2% in 2008,
compared to the market rate of 4.6% for a 20-year loan. It is quite evident that local
politicians prefer to spend their limited budgets on roads, schools and parks, rather than the
invisible infrastructure below our feet, for which they will get little recognition.

EPA Grants
Alongside traditional SRF funding, in 1989 Congress began providing further assistance to
state and local governments by appropriating funds to the EPA, which would then be used to
fund specific projects. These grants need not be repaid to the federal government, with the
federal government providing 45-55% of the total funds required, with the respective local
government providing the rest. The EPA has provided $7.1B in funds through FY08, funding
3120 projects across the country. Total EPA funding is less than 8% of what has been offered
through the SRF programs and is barely more than combined CW/DW SRF funding in
FY2010E. While EPA funding provides a needed supplement, it is hardly enough to consider
it as a significant funding source. No projects grants were awarded in FY07, as Congress
 was unable to enact appropriations before the start of the fiscal year. As seen in the charts
below, EPA grants can indeed be lumpy and sporadic and as such are not suitable to support
the growing need for infrastructure spending. Furthermore, funding is unpredictable and
sporadic and can thus negatively affect covered companies.

Historical EPA Grants Total EPA Projects per Year

$900 1200%700 669

$800
1000%600
$700 520
800% 500 491
$600
$500 600% 400
339
$400 400% 282
300 244 259
$300
200%
M
in D
o
la
rs

$200 200 143

0%
$100 100 46 42
$0 -200% 4 4 2 8 13 9 20 21 2 2
89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 0
Total Grant $ Value % Change in Funding 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

Water Protection and Reinvestment Trust Fund – Pending Vote

Representative Earl Blumenauer (D-Ore), along with four co-sponsors, recently introduced
bipartisan legislation to develop a Water Trust Fund to fund America’s growing
water/wastewater infrastructure problems. Dubbed the “Water Protection and Reinvestment
Act” (H.R.3202), Rep. Blumenauer noted a recent CBO estimate that suggests the act could
generate at least $10B a year. These funds would be generated through numerous small
taxes applied to beverages (4%), pharmaceuticals (0.5%), flushable products (3%) and a
0.15% fee of corporate profits over $4M, thus providing a deficit-neutral alternative for
funding water infrastructure projects. We note that similar trust funds exist for both
highways ($30B/year) and airports ($10B/year).

The act proposes that 48% ($5B) be allocated to the CWSRF and 35% ($3.5B) be allocated to
the DRSRF. The remaining funds would be spend on security enhancements (0.5%), sewer
overflow control grants (5%), R&D (5%), climate change (1%) and training programs (0.2%).

We believe this to be a healthy alternative to rate increases, as it reduces the burden

ratepayers currently shoulder. H.R. 3202 was referred to the subcommittee on Energy and
Environment and voting has yet to be scheduled.
 Water vs. Highway
Annual spending on water/wastewater construction remains significantly less than spending
on highway and street projects. We make this comparison as Highway infrastructure is
heavily subsidized by the federal government and is possibly a model for what may happen
in the future for water infrastructure funding, given the legislation discussed above.
According to the Congressional Budget Office, the state and federal government share the
burden of highway construction, with states covering 55% of the projects cost and the
federal government covering the remaining 45%. As mentioned previously, 90% of the
funding for water/wastewater infrastructure improvement is covered through rates. Since
1993, revenue from state water supply and wastewater operations has been used almost
exclusively to fund expansion and upgrades, as seen in the correlations below. Revenue is
driven almost entirely by water volume sold and the rates charged for that water.

While in total dollar terms funding for water/wastewater infrastructure remains abysmal
compared to highway and street spending, the annual percentage increases in spending are
in line with each other. While some variations have occurred over the years, funding for
both types of projects has increased by approximately 6% annually.

Annual Value of Public Construction Put in Place US Public Construction Spending Index

90,000 255
80,000 235
70,000 215
60,000
195
50,000
175
40,000
155
30,000
M D

135
in o
la
rs

20,000
10,000 115

0 95
93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 75
93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
Highway and Street Water and Sewage
Water & Sewage Highway and Street
Source: Census Bureau and Longbow Research Source: Bloomberg and Longbow Research
 Annual State and Federal Infrastructure Spending Annual Infrastructure Spending

160,000 200,000
140,000 180,000
160,000
120,000
140,000
100,000
120,000
80,000 100,000
60,000 80,000
40,000 60,000
D M

M
6
0n
f2
ailo
s

D
r

6
0
a
rn
f2
ilo
s
20,000 40,000
20,000
0
0
56 60 64 68 72 76 80 84 88 92 96 00 04
56 60 64 68 72 76 80 84 88 92 96 00 04
Federal - Highways Federal - Water/Wastewater
State - Water/Wastewater State - Highway Total - Highway Total - Water/Wastewater
Source: CBO, Longbow Research Source: CBO, Longbow Research

Correlation (Water Supply Rev:Exp) 0.9920

Correlation (Sewage Rev:Exp) 0.9779

As seen in the charts above, annual infrastructure spending has risen considerably over the
years. While states do indeed shoulder much of the burden for their roads and water
systems, the federal government does try to ease the pain. Aside from considerable funding
increases in the late 70s and early 80s, federal funding of water/wastewater systems has
remained flattish. Since 1957, yearly water/wastewater spending has increased, on average,
3.2% and since 1991 spending has increased 2.0%. In comparison, since 1957 yearly
highway spending has increased, on average, 1.9% and since 1991 spending has increased
2.1%. A notable increase in funding occurred in the 70s and 80s, when annual increases in
funding ranged from 8-14% for ten years (1971-80), compared to highway construction
funding which actually decreased upwards of (8%) during that same period. During that
time, spending on new construction surpassed O&M for the only time in our observed time
period, partially due to the Clean water Act of 1972, the Safe Drinking Water Act of 1974,
and other federal environmental legislation. The decrease in highway spending may be
attributed to the OPEC Oil Embargo, during which the price of oil reached $100/barrel (2008
dollars). This, in turn, resulted in lower gas receipts, which are used to fund the majority of
highway and street construction.
 % of Total Federal Infrastructure Spending Annual Capital and O&M Spending

70.0% 60,000

60.0%
50,000
50.0%
40,000
40.0%

30.0% 30,000

20.0% 20,000

D
6
0n
f2
a M
ilo
10.0%

rs
10,000
0.0%
56 60 64 68 72 76 80 84 88 92 96 00 04 0
Highways Mass Transit 56 60 64 68 72 76 80 84 88 92 96 00 04
Water Transportation Water Resources New Construction Operation and Maintenance
Water / Wastewater Source: CBO, Longbow Research
Source: CBO, Longbow Research

The federal government has slowly been increasing funding for water/wastewater systems,
as a percentage of total funding, whereas funding for highways has decreased from 63% in
1956 to 42% in 2004. In the same time period, as a percentage of total yearly federal
infrastructure spending, funding for water/wastewater systems has increased from 19.4% to
27% in 2004, the highest level during our observed time period.

Indeed, during the same time period, while new construction rose only minimally, O&M
spending has grown an average of 4% annually. We expect O&M spending and new
construction spending to increase in the coming years given the growing understanding and
acceptance that improvements are imperative; however, we lack the visibility to forecast
future growth in spending.

Water Infrastructure Spending – Safe Bet during Economic Downturns

There have been eight official recessions, excluding the current recession, since 1957.
Federal funding for water/wastewater infrastructure projects during the studied recessions
only decreased once, by (3.8%) in the July 1981–Nov 1982 recession. Otherwise, funding for
water/wastewater infrastructure projects increased by, on average, 3% during the studied
recessions, which is in line with average annual funding increases during non-recessionary
periods. Annual percentage changes in funding ranged from (3.8%) to 9.8%. Conversely,
annual funding for highway infrastructure projects decreased in four of the eight recessions
since 1957; however, the average annual increase was 0.8% during the studied recessions.
Annual percentage changes in funding ranged from (7.5%) to 11.2%.
Annual % Increase/Decrease in Funding During Recessions (1957-
2001)

15.0%

10.0%

5.0%

0.0%

-5.0%

-10.0%
57-58 60-61 69-70 73-75 80 81-82 90-91 2001

Highway Water
Source: CBO and Longbow Research
 Annual Funding
Increases/Decreases during
Recession
Highway Water
57-58 11.2% 3.0%
60-61 -1.0% 4.9%
69-70 -1.7% 2.8%
73-75 -4.1% 9.8%
80 4.5% 2.8%
81-82 -7.5% -3.8%
90-91 1.3% 2.8%
2001 4.0% 1.7%
Average 0.8% 3.0%

Global Water Prices – U.S. Pricing Has Room to Rise

Water rates are primarily dependent upon three factors: (1) the cost of pumping and
transportation, (2) total demand, and (3) water quality treatment. The Earth Policy Institute
reports that municipal water rates have increased 27% in the United States over the last five
years, compared to 32% in the United Kingdom and 58% in Canada. According to a study
done by Bagder Meter, Inc (BMI: NC), in the 50 largest U.S. cities, the average cost of water
is $3.37 per thousand gallons, whereas the price is upwards of $10 in Europe. Some cities in
the U.S. are similar to their European counterparts – Atlanta charges over $6 per thousand
gallons and Pittsburgh charges $8.18 per thousand gallons. We note, in order for ratepayers
to fund the estimated $25B annual infrastructure need over the next 20 years, rates would
have to roughly double across the country. The water industry is a “rising-cost” industry, in
which rates are currently growing at approximately twice the rate of inflation.

Water prices tend to be higher in Europe for numerous reasons, including the three drivers
mentioned above, but also because of the high level of privatization in Europe. Private
companies, many of which are regulated (ie: OFWAT in the UK), must charge higher rates in
order to (1) pay taxes, (2) earn a respectable ROE, and (3) private companies are more
adamant about updating its infrastructure network.

In most parts of the U.S. the daily water bill is not much more than $1 per day, which is
relatively low in comparison to other traditional utilities. This presents an opportunity for
water utilities to increase rates to pay for large infrastructure spending needs as large (but
gradual) percentage rate increases may not be opposed by paying customers. We presume
that rates will continue to increase, on average, across that nation in the coming years. If
this proves to be correct, annual infrastructure spending on the state and local level should
rise, as well.
 Cost of Water by Country (cents/m3)

350
300

3)
250
200
150
100
tfW

50
/m
n e
a
r(c C
o
s

Source: NUSConsulting Group

Need by Project Type and Companies Positioned to Benefit

A recent survey by the EPA found that total nationwide infrastructure need is $334.8 billion
for the 20-year period from January 2007 through December 2026. Project categories
include transmission and distribution (60%), treatment (22%), storage (11%), and source
(6%).

Transmission and distribution rehab and replacement projects are the greatest area of need,
with over $200.8B in forecasted need through 2027. While underground mains go unseen, it
accounts for the majority of the water infrastructure network in the United States. This
segment includes the outright repair and replacement of mains, as well as such products as
valves, flow controls, backflow prevention devices and meters to record water consumption.
The treatment category is the second greatest area of need, with approximately $75.1B
forecasted over the next 20 years. The majority of projects in this category are regulatory
driven and unlike the others are actually mandated by law. Projects include the new
construction and rehabilitation of treatment facilities (filtration, disinfection), which includes
the growing desalination market and membrane technology markets.

Storage projects ($36.9B) primarily include the construction or rehabilitation of water

storage tanks. The source category ($19.8B) entails projects related to the new construction

Cost of Water by Country (cents/m3)

Storage TotalNational Need:

Other $36.90 $334.8B
Source $2.30
$19.80

Treatment
$75.10

Transmission
and Distribution
$200.80

and rehabilitation of water intake structures, drilled wells and spring collectors.
 Public U.S. Companies with Water Infrastructure Exposure
Company Ticker Description Mkt Cap
Supplies concrete cylinder pipe, prestressed concrete
Ameron International
AMN cylinder pipe, steel pipe, and reinforced concrete pipe for 688.73M
Corporation
water transmission and waste water collection.
Manufactures and sells products and equipment for the
sanitization and treatment of residential and commercial
Arch Chemicals Inc. ARJ 688.73M
pool and spa water, drinkingwater, and water used in
industrial applications.
Manufactures flow measurement and control products for
Badger Meter BMI 564.18M
water utilities, industiral customers and municipalities.
Designs, manufactures, and sells water safety and flow
Flowserve Corp. FLS control products for the water quality, water safety, 4.81B
water flow control, and water conservation markets.
Designs and manufactureres pumps and related fluid
Gorman-Rupp Co. GRC 382.76M
control products worldwide.
Provides construction services and related products to
Layne Christensen LAYN the water infrastructure and mineral exploration markets. 484.91M

Manufacturers water infrastructure and flow control

Mueller Water
MWA products for use in water distribution networks and 499.48M
Products, Inc.
facilities.
Manufactures large-diameter, high-pressure steel
Northwest Pipe Co. NWPX pipeline systems for use in drinkingwater infrastructure 321.17M
applications.
Owns and develops water resources and water storage
PICO Holdings Inc PICO 553.52M
operations in the southwestern United States.
Engineering, technology, construction, fabrication,
Shaw Group SGR 2.54B
environmental, and industrial services.
Engineering, construction, and technical services to the
URSCorp. URS power, infrastructure, Federal, and industrial and 4.19B
commercial markets.

Conclusion
We believe that a windfall of funding for water/wastewater infrastructure projects is
forthcoming. Though we cannot predict when this may occur, we believe that such funding
will either come from gradual rate increases, federal government funding, or through the
Water Trust Fund.

Given the evidence, it is evident that the government has been unable to support the
monetary needs of water/wastewater infrastructure improvement projects. We believe the
federal government is keen on improving the nation’s infrastructure network, but simply
cannot carry the burden itself. Private water utilities, which currently only service 8.8% of
the U.S. population, are slowing being offered greater incentives and the freedom to finance
infrastructure improvement projects. While the transition from public to private has been
slow, we expect the trend toward consolidation and privatization to continue in the coming
years, due to high capex needs and fragmentation in the industry. Simultaneously, rates
should continue to rise and narrow the gap between U.S. rates and our European
counterparts, so that ratepayers can continue shoulder a portion of the burden.